Why Just Raising Wages Won’t Help the Economy

You know the argument: If we legislate an increase in wages, we’ll add $100B more to the economy. Gee, that sounds great. Why not raise wages by ten times as much and we’ll see an increase of $1T instead.

The issue with this idea is that it ignores what is going on when someone is paid for work they are doing. You see, when you work for an employer, you are doing something that is needed in order for your employer to do something for other people. For example, if you work at McDonald’s, you are helping your employer feed hungry people. If you work in construction, you are helping your employer to build shelter for people.

In exchange for what your employer is doing for these people, they do something that someone else needs of equal value. Before they walk in the door of McDonald’s they have, perhaps, made a pair of socks for someone else. They are trading the pair of socks they made for that quarter pounder with cheese and a drink that the McDonald’s employee makes for them. You just don’t realize it because they trade the socks to someone else who gives them a voucher, called money, that they can trade to McDonald’s for the food. When they give the voucher to the McDonald’s employee, it only has value because McDonald’s did something to earn it – they provided food to the customer. They created something or did something that was worth that voucher.

To see it more clearly, imagine if there were two farmers and each one grows corn. For some weird reason, rather than just eat their own corn, Farmer A gives Farmer B a bushel of corn that he grew. In exchange, Farmer B gives Farmer B a bushel of corn that he grew. They are exchanging things of equal value. Neither one feels cheated, and neither one would squawk at working to grow another bushel and exchange again in the future. In actuality they would be exchanging different things, but the point is that they are exchanging things of equal value and each needs to do something for the other.

Now what if Farmer A needed to be paid 2 bushels the next time for the bushel he was giving Farmer B because the government forced Farmer B to pay Farmer A more? Farmer B would rightly feel cheated. Before he would trade again, he would raise his prices to two bushels per two bushels so that the trade would be fair. This would mean that Farmer A would be paid more, but now prices would be higher so he would not be getting any more spending power. If Farmer B could not raise prices, he would probably choose to just eat his own corn and not trade since what he had to trade was worth more than he was receiving in exchange.

If wages are artificially raised, such that the same amount of work is done but the employees are paid more, the same thing will happen. If a worker at McDonald’s now gets paid $15 per hour instead of $7.25, you’ve now given him a voucher for two more Big Macs per hour. The trouble is, someone needs to produce those two more Big Macs in order for him to use those vouchers. But those Big Macs were never produced – a voucher was just printed. Instead of the emplouyee now being abel to buy more for each hour he works, the price of Big Macs will double. And so will the price of clothes, rent, and everything else. Soon, everyone will be right back where he started.

But what if you link the minimum wage to inflation, where wages increased when prices went up? Well, because you would now be asking the employer to pay more than he was receiving from the work that was being done, the result would be the same as when the farmer decided not to trade and just ate his own corn. In the real world, an employer must make enough money from having employees to justify the cost of hiring them and dealing with them. If wages are artificially high, an employer may choose to do work with fewer employees or maybe just work the business himself and not expand if wages are required to be too high. What sense would it make to grow bigger if he was losing money with every employee he hired?

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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